Outsourcing Chasing Cheap Labor to the East

By Peter Gumbell, Time Europe, Sunday 4 April
2004

Talk about investment flows. A decade ago, foreign investment began to
pour into Poland, the Czech Republic and Hungary as West European and
U.S. companies looked for a low-cost manufacturing base close to the
European Union. Today, as these and seven other countries join the
E.U., the East and Central Europeans themselves are looking east for
low-cost manufacturing. As rising wages force them to find ways to
become more competitive, some are setting up plants or outsourcing
their production to subcontractors in places like Bosnia, Romania,
Russia and Ukraine. The investment farther east isn't yet a flood,
but economists and trade experts expect it to increase substantially
in the next few years as living standards—and manufacturing
costs—continue to rise. It's a sign of maturity, says
Willem Buiter, chief economist at the European Bank for Reconstruction
and Development.

Hungary is leading the charge. Between 1998 and 2003, Hungarian
companies invested $2.9 billion abroad, mostly in other East and
Central European nations. Much of it went toward acquisitions, but
some involved outsourcing. There are roughly 4,000 Hungarian firms in
Romania and up to 30% of them are outsourcing related, according to
Péter Spányik, CEO of the Hungarian Investment and Trade Development
Agency.

Companies elsewhere are following suit. Poland's Forte Group, a
big furniture manufacturer, has acquired a factory in Ukraine and
recently decided to build a plant in Russia. Forte vice president
Andrzej Korzeb says Russia has attractive tax rates (as low as 13%)
but cheaper labor is also a factor. Zygmunt Berdychowski from
the Institute of Eastern Studies in Warsaw says that small- and
medium-sized firms along the new E.U. border are investing modest
amounts—often less than $1 million—in facilities in Russia
and Ukraine.

One Czech company, Moravan-Safety Belts, has been producing safety
belts in Russia since 2001. The production was originally for the
Russian market, but the firm now imports Russian-made components for
assembly in the Czech Republic. The next step will be to move all
assembly to Russia, where costs are 15% to 20% less than at
home. The pressure of the market is constantly on lowering prices
and that cannot be achieved in our environment, where costs are
rising, says deputy chairman Tomás Stefánek. But outsourcing can
be as controversial in the East as it is in the West. When Ceská
zbrojovka, a major Czech gun manufacturer, decided last year to move
its air-gun production to Slovakia and upped domestic production
quotas, it had to work hard to avert a strike by labor unions.

Some companies are already looking far beyond their immediate
neighbors—to China and other parts of Asia, where labor costs
are lower still. Hungary's Budmil, which makes sports and leisure
gear, now sources 70–80% of its production in China, India, Taiwan,
Turkey and Vietnam. It still uses Hungarian manufacturers, but only
for sophisticated products and small orders that would be uneconomical
to produce in Asia. We moved toward the Far East because we wanted
to keep our ability to compete, says András Hegedus, a board
member. As production costs in the new member states start to approach
those in Western Europe, more and more firms could be eastward bound.

With reporting by Tadeusz L. Kucharski/Warsaw and Jan
Stojaspal/Prague
From the Apr. 12, 2004 issue of TIME Europe magazine